ATTACHMENT: THE 8 BADGES OF FRAUD
December 14, 2006
Few things are more frustrating to creditors than debtors transferring assets to affiliated entities in order to avoid collection efforts. Such conduct was the subject of a November 14, 2006 decision by United States Magistrate Judge Christopher A. Nuechterlein of Indiana’s Northern District. See, Lock Realty Corp. v. U. S. Health LP, 2006 U.S. Dist. LEXIS 84420 (N.D. Ind. 2006)-lock_opinion.pdf.
The facts. In a prior case, Plaintiff Lock Realty Corp. obtained a judgment in excess of $485,000 against defendant U.S. Health LP for breach of a lease. Lock later added defendant Americare III LLC to the judgment because U.S. Health unlawfully assigned the lease to Americare, which was part of a single business enterprise with U.S. Health. In fact, U.S. Health utilized roughly eighty-three entities to shelter itself from liability. Lock then filed the current lawsuit against U.S. Health for additional damages (over $10 million) associated with lease breaches that occurred after the entry of the prior judgment. About six weeks after Lock filed the second suit, U.S. Health sold four nursing home units to a third-party for approximately $3 million. U.S. Heath transferred the sale proceeds to Heritage Medical Group, Inc., the managing partner of U.S. Health and one of the eighty-three entities that made up the U.S. Health enterprise.
Attachment. In an effort to prevent U.S. Health from concealing assets that may be available to satisfy a judgment in the second suit, as well as the judgment from the first case, Lock filed a motion to attach the proceeds of the $3 million sale. Ind. Code § 34-25-2-1(b)(5) is the statute upon which Lock’s motion was based:
(b) The plaintiff may attach property when the action is for the
recovery of money and the defendant:
(5) has sold, conveyed, or otherwise disposed of the
defendant’s property subject to execution, or permitted
the property to be sold with the fraudulent intent to cheat,
hinder, or delay the defendant’s creditors . . ..
Attachment generally means “the act or process of taking . . . property, by virtue of a . . . judicial order, and bringing the same into the custody of the court for the purpose of securing satisfaction of the judgment ultimately to be entered in the action.” Blacks Law Dictionary.
Fraudulent intent. The issue was whether U.S. Health acted with fraudulent intent to cheat, hinder or delay. In Indiana, there are eight common law “badges of fraud” from which fraudulent intent in a given transaction may be inferred:
1. Transfer of property by the debtor during the pendency of a suit.
2. Transfer of property that greatly reduces the debtor’s estate.
3. A series of contemporaneous transactions that strip a debtor of all property available for execution.
4. Secret or hurried transactions not in the normal course of business.
5. Any transaction not conducted in the normal course of business.
6. A transaction conducted in a manner differing from customary methods.
7. Little or no consideration for the transfer.
8. A transfer of property between family members.
No single factor constitutes fraudulent intent. Rather, the facts must be viewed together to determine how many badges of fraud exist and if together they amount to fraudulent intent. (Keep in mind that attachment cannot occur in every case. For instance, Microsoft may have multiple transactions ongoing during litigation, but those transactions aren’t necessarily fraudulent, in part because few if any transfers would render Microsoft judgment proof.)
Magistrate Nuechterlien granted the motion for attachment because Lock established that several badges of fraud existed, including:
• U.S. Health transferred property while the second suit was pending and while it had failed to satisfy the judgment from the first suit.
• The U.S. Health enterprise had been reduced by $3,000,000 after it sold four of its facilities.
• U.S. Health and Americare essentially were one entity, so property Americare transferred was subject to execution by Lock.
• The proximity of the final sale appeared “suspect and uncustomary.”
• U.S. Health had retained benefits of the transferred property because the proceeds were given to Heritage, simply another entity in the U.S. Health enterprise. “This is no different than taking money out of one’s left pocket and putting in one’s right pocket.”
The lessons of Lock. The Lock ruling reminds us that attachment can be a valuable tool in cases where a defendant is utilizing affiliate entities to hide money. If you suspect that a borrower, during litigation, is burying assets in associated companies merely to avoid your collection efforts, look for the eight badges of fraud. You might be able to freeze the assets pending the outcome of the suit.
Update: On September 14, 2009, Judge Miller issued a thirty-three page opinion in the Lock Realty v. U.S. Health case. Click here for a .pdf of the order. The decision outlines the procedural history, facts and substantive issues (both liability and damages) in the litigation. The opinion isn't necessarily pertinent to my blog, but it does tell more of the story behind the case for those interested.